Think buying a second home is only a dream?
Think having a vacation spot all to yourself, with no reservations and no per-night payments is only for the extremely well-to-do?
According to the National Association of Realtors, 21% of all homes sold in the United States in 2015 were vacation homes. That’s more than one in five! And these aren’t just condos, apartments, or duplexes; over half were detached single family homes. The median price was a very affordable $150,000, and about 70% used a mortgage to make the purchase.
All of these numbers add up to one essential point: owning a second home is more common, and it’s more accessible, than you might have thought.
Perhaps it’s time you explore the possibilities of a second home and see if it’s a possibility in your future. You may be pleasantly surprised!
What You Need to Know About Financing a Second Home
Why is Financing a Second Home Different?
As we demonstrated, owning a second home or a vacation house is possible for many people, not just the extremely wealthy. However, we don’t want to imply that financing for a second home is simple or easy. Compared to first-home financing, there are a few more challenges and requirements involved.
As the buyer of the second home (and a second mortgage), you’ll have to split your income between two properties. Lenders will reasonably assume that if owners of second homes come across financial troubles, they’re more likely to stay current on the primary residence, not the vacation property. After all, it wouldn’t make sense to stay current on the vacation house if your primary home is going into foreclosure.
This makes lenders more hesitant to underwrite loans on second homes and forces borrowers to go through a more rigorous approval process.
How is the Process for Financing a Second Home Different?
As you seek approval for financing a second home, you’ll find that a few factors are different.
Higher Down Payment Requirements
In many cases, you can purchase a primary home with 3% down. It’s even possible to purchase a home with 0% down. The VA and FHA also insure loans with no down payment, but these government-backed loans are not available for second mortgages. With second homes, you’ll likely need to bring a larger down payment, usually at least 10%. If your application isn’t very strong, you may need to bring as much as 20% for a down payment.
Slightly Higher Rates (Possibly)
Because of the increased risk, lenders will protect their investment by requiring slightly higher interest rates on the loan. The specifics will vary depending on your credit score and other factors, but it’s not uncommon for second-home mortgages to have a slightly higher interest rate.
Reserves May be Required
In addition to the larger down payment, you’ll probably need to prove that you have cash reserves in the bank. Reserves are funds that are available to help you pay the mortgage if you have a problem with your income. For a second home, expect to have a reserve of at least two months, and at least six months if you are self-employed or don’t have a strong credit score.
Credit Score Requirements are Higher
For fixed-rate loans on a primary residence, Fannie Mae requires at least a 620 credit score. To qualify for financing on a second home, however, you will likely need a higher credit rating. In many cases, you may need a credit score of 640 or higher to qualify.
DTI Requirements Will Become a Factor
The debt-to-income ratio requirements will also be more strict. Many lenders will allow for a debt-to-income ratio of 45% or higher in some cases. As far as the lender is concerned, the less money you owe compared to your monthly income, the better. When the DTI approaches 50% (half your income goes to debt payments), they start to show concern. A second home will add to your debt load, so if you are already at 40% DTI, and the second-home mortgage pushes it to 55%, the lenders may be more hesitant to write the loan.
Other Factors to Consider When Purchasing a Second Home
Outside of the mortgage and financing, there are a few factors that will affect the overall financial costs of owning a second property.
Insurance Can be Higher
Getting affordable insurance can be difficult on a second home for many reasons. In most cases, your vacation home will be located miles away. (The National Association of Realtors says the median distance between a primary residence and vacation home is 200 miles). Who will be caring for the home? Will the place be properly maintained? Will anyone know if a pipe leaks? Because of the challenges to maintenance, basic insurance, not to mention flood, hurricane, or disaster insurance, can be more expensive.
Don’t Forget Property Taxes
Taxes are different everywhere, so make sure you know how much you’ll spend every year on tax payments for your vacation home. This can be an important factor to the overall affordability of a vacation home.
Who’s Doing the Upkeep
As we discussed earlier, upkeep and maintenance on a vacation home can be a challenge. You’ll likely need to hire someone who can mow, trim, inspect the home, or winterize it if you won’t be there during the cold months. While vacation homes in the San Diego area might not require much winterization, a vacation home on a wooded Minnesota lake will require pipes to be shut off, docks to be pulled, windows to be wrapped, and doors to be properly sealed. Vacation homes can be a lot of work, and you may need to hire out these services.
Before you buy, make sure you understand all the details of keeping the home, no matter where it’s located.
Talk with an Expert About Your Options for Financing a Second Home
A vacation home may be closer than you think. Talk with the experts at San Diego Purchase Loans to learn more about the available options for second-home financing.
We’ll help you make the right decision for your financial future, so contact us today!
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